Annual producer price inflation slowed to 2.4% in July from 2.5% in June, the National Bureau of Statistics said on Friday. Economists had expected a rate of 2.6%.

Whereas food accounts for about a third of the consumer price basket, it makes up only about 10% of the producer price index, economists said.

"It has a higher weighting towards industrial goods. So it better underscores the fact that inflation pressures are mainly related to food rather than industrial goods," said Ben Simpfendorfer, an economist with Royal Bank of Scotland in Hong Kong.

The benign report lends support to the argument that, although the Chinese economy has been growing at a double-digit pace for five years, competitive pressures and productivity gains are keeping a lid on broad inflationary pressures.

"It's a figure that should give investors less reason to panic when we get a high-side CPI on Monday," he added.

Economists polled by Reuters expect consumer price inflation to accelerate to 4.9% in July from 4.4% in June.

Simpfendorfer expects a rise of more than 5% and there are rumours in financial markets that it could be as high as 5.6%, the highest in a decade.

"I don't know if that would provoke a monetary policy response but I do think the PBOC will worry about inflationary expectations and the potential impact on wage costs," he said.

A state think-tank said on Friday that even a rise in the consumer price index of 5% was unlikely to spell serious inflationary trouble for the economy.

"China's current economic growth can withstand CPI growth between 3 and 5%," the State Information Centre said.

Shaping Expectations

The think-tank said consumer prices were likely to rise 4.3% on average over the third quarter compared with increases of 4.4% in June and 3.2% in the first six months.

The People's Bank of China, the central bank, has raised interest rates three times and banks' required reserves six times so far this year to mop up excess liquidity and prevent the world's fastest-growing major economy from overheating.

The bank said on Wednesday in its latest monetary policy report that it would keep leaning to a tighter policy to rein in prices and curb inflationary expectations.

Xue Hua, an analyst at China Merchants Securities in Shenzhen, said the drop in wholesale inflation in July reflected a high base of comparison in 2006.

He calculated that, from month to month, producer price inflation is still quickening -- to 2.75% in July, at an annualized rate, from 2.6% in June.

"PPI is still on the rise," Xue said. "I think monthly PPI growth will continue to pick up in August before declining in September or October."

A breakdown of the figures shows foodstuffs in July cost 7.8% more at the wholesale level than a year earlier, compared with a 6.7% increase in the year to June.

Prices for steel products, ferrous metals and coal also rose more quickly, but there were outright falls in the cost of crude oil, gasoline and consumer durables, the statistics office said.